Does your portfolio suffer from home bias?

Home bias, or the preference of investors to allocate heavily to their home financial markets rather than diversify globally, is a phenomenon demonstrated by investors across most markets. The GCC including Bahrain is no exception to the home bias preference.  The intuitive response to ‘buy local’ has been seen to greatly outweigh the benefits of diversification, but in an increasingly globalised market, with easy access to a range of financial instruments across asset classes, why is this bias still pervasive?

How much home bias do investors have?

A recent study by the Atlanta Fed measured the extent of home bias by looking at actual investor allocation to domestic equities relative to that market’s weight in global markets from a market capitalisation perspective. For example, US equities constituted about 50% of global market capitalisation at the time of the study, but data showed US investors allocated about 90% of their equity investments to US markets. This gap was even wider for other major markets. The bias for investors to invest primarily in domestic financial assets is significant.

Various studies have attempted to understand why investors demonstrate this preference. One possibility is the cost of investing globally. This can be prohibitively high in some markets, though for many major markets it is often not high enough to outweigh the benefits in terms of investment returns and volatility reduction.

A second possibility is information asymmetry.  Investing locally comes with the appeal of adding exposure to ‘what I know’. While having a sufficient understanding of one’s investments is a fair ask, the same Fed study noted that the implicit ‘information’ cost of missing the benefits of diversifying globally appeared to be very high.

Third is an avoidance of taking on excessive currency risk. While this may be less of a challenge in equity markets, where FX volatility tends to be a smaller portion of returns over time, this can pose a bigger share of returns in asset classes such as bonds.

The GCC context

Several studies have examined home bias among GCC investors in recent years and results show that GCC investors also exhibit a strong home bias for local and regional markets[1].

The level of home bias is variable in the region, with one study concluding that professional investors in Qatar had relatively smaller home biases compared to fund investors in neighbouring markets1. While there are a range of factors that impact the degree of home bias, a key influence is the range of home market opportunities available at a given point in time.

When it comes to individual expatriate investors, though, most of the same studies show they do hold a home bias, but largely to their own home markets. This appears to hold across the region, not just in Qatar. And it is not surprising – one of the most likely drivers of home bias is familiarity with one’s home market. This can lead to less-than-optimal investor portfolios because investors usually benefit from diversifying globally as far as possible across regions, asset class and currencies.

Is home bias a problem?

An excessive home bias can hurt one’s financial health due a lack of diversification to mitigate impact of potential local or regional volatility.

For example, someone working in the energy industry who limits his/her investments to a domestic equity market which happen to have a large weight in the energy sector would be doubling up on the concentration risk in one industry. Even a normal cyclical downturn in the industry would pose a risk to such a non-diversified investor as their personal earnings and investment portfolio decline at the same time.

We can see this impact in terms of currency exposure as the table below illustrates, over the past two years, many major currencies, including those of Emerging Markets, weakened in the face of the unusually strong US Dollar. While this could partially reverse should the USD weaken in 2023, as we expect, even a small allocation beyond local market assets would have helped smoothen one’s investment performance.

Need for international diversification

Home bias, by its nature, means disproportionately larger exposure to one’s home currency, this does support in mitigating foreign exchange risk, it does not eliminate it completely.

While, perfectly integrated international financial markets remain a dream, and lower transaction and information costs will certainly help home bias to decline more steadily, investors must make a conscious decision to diversify globally as the benefits allow for greater portfolio diversification and more efficient allocation of capital resources.

By Manpreet Gill

Chief Investment Officer for Africa, Middle East and Europe at Standard Chartered Bank’s Wealth Management unit)


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